Fiscal divergence and its implications for reserve managers

Since the global financial crisis, a confluence of cyclical and structural factors has led to rising public-debt levels throughout the world. This trend appeared to have reversed in the immediate aftermath of the Covid-19 pandemic, with high nominal growth and post-pandemic fiscal consolidation leading to a brief respite in the decade-long trend of rising public-debt burdens. Nevertheless, the Russian invasion of Ukraine and resulting increase in defence expenditures, increasing pressures for social and healthcare spending, the cost of the climate transition, and challenging demographic trends have all reversed the post-pandemic declines in public-debt ratios and undermined attempts at fiscal consolidation. Loose fiscal policies and still-tight monetary policies that resulted from the post-pandemic rise in inflation have garnered the attention of global investors. According to the latest Financial stability report conducted by the US Federal Reserve, and reported to Congress, over 70% of investors cited persistent inflation and monetary tightening as a risk to financial stability, and over 40% also highlighted fiscal debt sustainability as another risk.¹ Other financial stability reports prepared by the Financial Stability Oversight Council and the International Monetary Fund highlight concerns about topics related to fiscal policy such as the growth of Treasury debt leading to problems with the functioning of the US Treasury market.

This chapter aims to unpack global fiscal trends and draw some useful conclusions for reserve managers. To better serve our intended audience, we mostly look at emerging and developed economies included in the major bond indices (EMBI and WGBI). However, at times, we broaden our scope to most countries covered in the IMF’s World Economic Outlook (WEO) survey.

The first part of this chapter aims to shed light on growing fiscal risks by decomposing factors driving rising public debt and highlighting the policy implications of this dynamic. The chapter also attempts to highlight regional differences in debt trends and decompose the importance of different drivers in advanced and emerging economies. The chapter then explores specific drivers of public debt in China and the US – by far, the two largest contributors to the rising global public-debt trend. The second part of this chapter examines the rest of the world, and in particular the large group of countries whose debt dynamics have been more robust. In this section, we explain what factors have allowed these countries to maintain better debt trends and determine whether these benign debt dynamics are likely to last in the future. We also explore whether there is a correlation between debt dynamics and sovereign bond performance. The chapter ends with a short section drawing conclusions on these diverging trends for both policy-makers and investors in government debt.

Decomposing drivers of rising public debt

The long-term evolution of public debt is driven by three principal factors:

• Primary fiscal balances.
• The rate of interest the government must pay on public debt.
• Economic growth.

Each of these in turn is driven by both structural and cyclical factors. In this section, we provide an overview of some of the most significant structural drivers of public debt that have a bearing on investors’ perceptions of sovereign risk.

Fiscal policy stance

Over the past couple of years, looser fiscal policy has increased in importance as a driver of rising public debt. Looking at the trajectory and outlook for primary balances is a good starting point. Economies with persistent revenue shortfalls tend to accumulate public debt, implying an inverse relationship between primary balances and public-debt ratios, something we find in figure 1. The more an economy is towards the top left of the scatter chart, the greater scrutiny it will attract from the perspective of long-term debt sustainability. The notable members of this side of the figure are advanced economies such as Japan, the US, France, Italy and the UK. In the analysis below, we will see that this will be part of a recurring theme.

The behaviour of primary balances is obviously not static, and we see significant shifts over time. In figure 2, we show the average trajectory of primary balances over five-year windows before and after the onset of Covid-19, along with the five-year forecasts from the IMF’s Fiscal Monitor database. For most countries, we see a clear pattern of primary balance deterioration during the Covid pandemic, as most governments chose to provide a backstop to the private sector during the lockdowns. Moreover, some governments, such as the US’s, continued to provide highly generous handouts well after the initial crisis was over. A closer examination of post-pandemic fiscal trends shows that most countries took advantage of favourable cyclical dynamics in 2021–22 to impose some degree of fiscal consolidation. Nevertheless, after 2021, the fiscal consolidation trend began to lose momentum in most places, with the IMF’s WEO data clearly showing primary fiscal balances eroding throughout most of the world relative to the pre-pandemic period (see figure 2).

An examination of 137 countries forecasted in the IMF’s WEO shows that the median primary fiscal balance as a share of GDP had deteriorated by 0.4% of GDP relative to the average primary fiscal balance in the five years preceding the pandemic.² Large Group of Seven economies were among the countries that experienced significantly larger fiscal deteriorations. Germany and Italy show a degree of primary balance deterioration that is one standard deviation beyond the mean, while France and the UK come close to the one-standard deviation cut-off, as well. While in Germany the pre-pandemic fiscal balances were robust,³ and current fiscal deficits are unlikely to be meaningful contributors to debt dynamics, the same cannot be said for Italy, the UK or France, where primary deficits exceeded 3% of GDP. China has also posted a significant deterioration in primary fiscal balance that falls just shy of one standard deviation beyond the mean. While the deterioration in the US’s fiscal balance does not look particularly remarkable, it is worth highlighting that fiscal deficits in the world’s largest economy have been deteriorating steadily for the past decade, with only a brief cyclical pause in 2021/22.

While global public-debt trends have deteriorated throughout the world, China and the US stand out. For more on the fiscal dynamics in the world’s two largest economies, see below.

US debt and entitlement spending

US federal government debt has more than doubled since the early 2000s, to reach approximately 120% of GDP by 2024 (figure 3). While the global financial crisis and the Covid pandemic led to sharp increases in the debt ratio, the rise also reflects a long-term underlying trend. The IMF expects debt to continue rising in the coming years, to surpass 130% of GDP by the end of the decade.

The rising debt ratio reflects an expectation that the federal budget deficit will remain wide throughout the 2020s. Indeed, after a modest, temporary narrowing in 2026 and 2027, the Congressional Budget Office sees the deficit reverting to a widening by the end of decade and into the 2030s (figure 4). Importantly, these figures do not take into account the potential deterioration in fiscal balances under the new US administration, which has pledged to extend the Tax Cuts and Jobs Act (2017) without an offset of spending cuts or tax increases in other areas.

The trend widening of the deficit began in the early 2000s, and reflects rising federal expenditure, rather than any meaningful decline in revenues (figure 5). The trend in spending does not reflect discretionary fiscal largesse, but instead has been a function of rising entitlement spending, itself in large part driven by an ageing population. The CBO forecasts that, without a meaningful shift in policies, these dynamics will continue (figure 6).

In recent years, a further factor has pushed up federal government spending – higher interest payments. With the 10-year US Treasury yield surging from below 1.0% in the aftermath of the pandemic to around 4.5% currently and the debt ratio jumping by almost 20 percentage points since 2019, federal net interest payments have risen to 3.5% of GDP from a recent low of approximately 2.0%. While the pace of increase is unlikely to be as pronounced going forwards, given that US rates seem to be settling at their new, higher level, the CBO projects a gradual rise in net interest payments relative to GDP over the next decade (figure 6).

Assuming US Treasury yields and nominal GDP growth both remain around their current rate of around 4.5%, stabilising the US federal government debt ratio would require pushing the primary budget deficit, which the IMF estimates to be over 3.5% of GDP in 2024 (figure 7), back into balance. This would likely prove to be challenging, even if spread over several years. As seen in other countries, cutting entitlement spending is unpopular, given the increasing political weight of retirees as the population ages. Cutting other forms of spending also presents challenges, given that discretionary federal expenditure is already projected to decline to multi-decade lows.

While there are no easy choices, raising federal taxes could ultimately prove to be the least unpalatable option. The CBO expects federal revenues to run at around 18% of GDP heading into the 2030s, slightly above their long-run average, but below the 20% peak seen in 2000. Moreover, US general government revenues as a share of GDP are low relative to many other major economies (figure 8), potentially making it easier for the US to rebalance the public finances.

The US economy’s dynamism could also provide some relief to the public finances. The US is leading the way on artificial intelligence investment, which could lead to stronger productivity over the medium term – as was seen in the late 1990s’/early 2000s’ IT boom. If so, trend nominal growth may exceed current expectations, helping to lower the debt and deficit ratios while also raising revenues and possibly reducing demand for expenditure. However, such developments are not guaranteed, and, in their absence, the US authorities may, over time, come under greater pressure to address the underlying trends in US public finances.

The case of China

China’s gross government debt-to-GDP ratio drifted gradually higher through the early 2010s, but since 2016 has been rising at a faster pace. This has left the debt ratio notably above the emerging market (EM) average and the IMF forecasts it to rapidly approach the advanced economy average over the remainder of this decade (see figure 9).

The structural slowdown in China’s growth rate, the headwinds it faces from oversupply in the property sector, and the low-inflation environment are well known and are putting pressure on the public finances. However, taking a step back, a key factor underlying some of China’s challenges remains the excess of domestic saving.

China’s gross saving rate rose through the early 2000s to reach over 50% of GDP in 2008. Despite gross investment also picking up during that period, it could not keep pace, resulting in the current account surplus peaking at almost 10% of GDP in 2007. The global financial crisis in 2008 then led to a collapse of foreign demand. To avoid this undermining China’s economy, the authorities pursued policies that ramped up domestic investment and encouraged a lower saving rate, which put the economy into better balance with the current account surplus shrinking to around 2.0% of GDP by 2011 (figure 10).

Since then, the current account surplus has averaged just under 2.0%. However, gross saving has remained far higher than in other economies (figure 11). This necessitates high levels of investment (figure 12) to avoid a deflationary outcome for China and a return to a much larger current account surplus. However, maintaining an investment share at a far higher level than other economies persistently over time eventually incurs diminishing returns – there is a limit to how quickly capital can be productively employed. China’s recent real estate crash provides a case in point.

Importantly, were it not for the significant widening in the general government deficit since 2016, China’s excess of saving over investment would be much larger. The country would have returned to running undesirably large current-account surpluses, reflecting much weaker private-sector domestic demand and higher savings (figure 13).

Stemming the rise in government debt therefore requires reforms to encourage private-sector consumption and reducing the desire to save. At present, this is made more challenging by the weakness of consumer confidence (figure 14). On the cyclical front, the government has taken several steps to try to boost consumer sentiment and spending, such as the subsidised trade-in programme to bring forward planned consumer durables purchases and cash handouts to lower income households.

Still, the high household savings rate also reflects some more structural factors or deeper-rooted obstacles within China’s economy. Demographics challenges stemming from the ‘one child’ policy, which results in parents spending less on raising their children, while saving more for retirement, given fewer children to support them in old age, are an important factor. A relatively weak social security net, a low share of labour income in national income, income equality and urban-rural disparity also contribute to the high saving rate.

The authorities have already announced plans to reform the personal income tax system, which, among other things, aims to unify the taxation of labour income and standardise the taxation of different types of non-labour income. The reforms could play a key role in income redistribution.

Action in a range of areas could also help reduce precautionary saving over the medium to longer term. For example:

• Strengthening the social security system.
• Increased government spending on healthcare, pensions, education and other public services.
• Improving migrant workers’ access to public services.
• Greater government assistance to the lower-income and vulnerable groups (which could help reduce income inequality).

Emerging EU and the war

Another group of countries that have seen substantial deteriorations in post-pandemic fiscal stances are those geographically close to the Russo-Ukrainian war. These countries were affected by significant terms-of-trade shocks at the onset of the war in 2022, cutting short nascent fiscal consolidations. Governments throughout central and eastern Europe were forced to implement substantial subsidies for food and energy, given supply shocks faced at the onset of the conflict. Defence spending has been another major driver in eroding fiscal balances in the region, with countries like Poland having more than doubled spending on defence as a share of GDP in the years following the start of the war.

While many countries in eastern Europe are now making efforts to consolidate fiscal accounts, by unwinding subsidy programmes and reducing capital expenditure, the prolonged period of fiscal stimulus prevented countries in the region from taking advantage of the cyclically favourable post-pandemic period in which GDP deflators were high and interest rates were low, missing a crucial opportunity to de-lever public-sector balance sheets.

Structural improvers

We should be careful not to paint the global theme with a single brush: fiscal policy has not driven deteriorating fiscal balances everywhere in the world. Two groups of countries stand out as having made significant improvements in primary fiscal balances relative to pre-pandemic averages. The first group are hydrocarbon exporters. Many hydrocarbon exporters – such as Norway, Azerbaijan and Kazakhstan – have managed significant improvements in their primary fiscal balances. In contrast to European countries that experienced a negative terms-of-trade shock after Russia’s invasion of Ukraine, many hydrocarbon exporters saw a positive terms-of-trade shock driven by spikes in the prices of oil and gas that created significant tail winds for fiscal consolidation. Structural factors are also likely to have played a role, as hydrocarbon exporters also tend to have more volatile economic cycles that can also partially explain the sharp improvement in fiscal stances once the global economy started to regain its footing.⁴

Countries that recently experienced sovereign-debt crises are the other group of countries in which fiscal stances appear to be outperforming the average in our sample. For example, the countries that were most severely affected by the eurozone crisis – Cyprus, Portugal and Ireland – posted significant fiscal surpluses in 2023 that were far higher than those in the pre-pandemic period. While Spain had a modest degree of fiscal slippage, the country has made steady progress consolidating its fiscal accounts post-pandemic, a trend that is forecast to continue in 2024/25.⁵ In many cases, fiscal consolidation in the eurozone sovereign crisis countries has been coupled with stronger growth, which should help support debt dynamics in the coming years.

The twin shocks of the pandemic and Russo-Ukrainian war also plunged many frontier countries into crisis. In these nations, fiscal consolidation has come from three predominant factors. First, a loss of market access following the rapid increase in developed market yields that made financing sizeable deficits unviable. This both forced fiscal austerity and, in many cases, led to sovereign-debt restructurings that lowered interest expenses resulting in lower nominal fiscal deficits. In many circumstances, frontier states also resorted to IMF programmes for external liquidity. In countries where IMF programmes have been successful – such as Costa Rica, Ecuador, Sri Lanka and Zambia – the structural reforms and fiscal consolidation that are conditional with IMF lending have improved fiscal balances and brought about ratings upgrades. In many cases, sovereign bonds in these emerging market countries have performed very well as a corollary.

Looking ahead, the IMF forecasts point to some degree of fiscal consolidation for many countries over the coming years, as economic expansions improve the governments’ revenue flows and primary balances are repaired amid lower expected spending. This pattern is not universal, however. Persistent primary deficits are still envisaged in major economies such as the US, Japan, China, Saudi Arabia and India, as per the IMF forecasts (black bars in figure 2). To what extent these persistent deficits are a concern for debt sustainability depends on underlying drivers such as the size of non-discretionary government spending, trend growth and debt-service capacity relative to the debt burden. We address some of these concerns next.

Interest liability and debt serviceability

One significant consideration for debt sustainability in a world of potentially higher-for-longer interest rates is the extent to which interest liability itself would contribute to debt burdens. Below, we analyse the evolution of real rate dynamics in the aftermath of the Covid pandemic and use the forecasts in the IMF’s Fiscal Monitor database to get a sense of some likely trends.

Non-fiscal debt dynamics have been characterised by two predominant trends in the post-pandemic period. First, significantly higher real rates in most of the world; and, second, an acceleration in nominal GDP growth. In figure 15, we assess changes in real rates and nominal GDP growth for 40 major emerging and developed economies and found that, in almost all economies, real rates are higher today than in the post-pandemic period.⁶ An interesting outlier is China, where lower post-pandemic real rates are correlated with a slowdown in economic growth, the ability of capital flow measures to keep capital in the country, and other aforementioned factors discussed in the China section above.

Our analysis shows that, on average, the increase in real rates has been higher in emerging market countries than in developed markets. A closer examination of the EMs in our sample shows two groups. The first group of countries, concentrated in Latin America and eastern Europe, experienced more pronounced spikes in inflation and meaningful accelerations in nominal GDP growth compared with the pre-pandemic period. This group of emerging markets also saw higher increases in real rates in the post-pandemic period as central banks reacted more forcefully to the threat of inflation. The second group of EM countries – predominantly South Africa and south and South-east Asian countries – saw more muted inflation pressures and unchanged, or slower, nominal GDP growth from pre-pandemic growth rates. This group of countries experienced less pronounced increases in real rates. Interestingly, on average, the public-debt ratios in the former group (the group that had higher real rates and higher nominal GDP growth) had more muted increases when compared with pre-pandemic levels. This is explained by increases in real rates being dominated by the acceleration in nominal GDP growth that drove the denominator in the debt-to-GDP ratio to outgrow the numerator in the years immediately following the pandemic.

While there are fewer obvious trends in the advanced economies, a couple of tendencies are notable. First, despite the sharp increase in public debt, the US is near the 45-degree line on the chart, which denotes where post-pandemic increases in real rates are offset by the post-pandemic acceleration in nominal GDP growth. This seems to suggest that most of the post-pandemic increase in US public debt has been driven by its loose fiscal policy stance, rather than the underlying drivers of debt dynamics. Second, advanced economies in Europe tend to have the least favourable underlying debt dynamics. Among the countries where post-pandemic increases in real interest rates have outpaced accelerating nominal GDP growth are the UK, France, Austria and Spain. Advanced economies that export commodities – such as Australia, Canada and Norway – appear to have more favourable interest liability where accelerating growth has outpaced rising real rates in the post-pandemic period.

Looking forward, figure 16 provides the changes in the IMF’s five-year r-g forecasts along with five-year forecast changes in the debt-to-GDP ratio. Here, the IMF is forecasting interest liability metrics worsening in many of the aforementioned countries that had seen larger increases in real rates than accelerations in nominal GDP growth (France, Brazil, Poland and the US). It is also worth noting that China is forecast to have a significant increase in interest liability despite being one of the few countries in the world that has seen real interest rates decline from pre-pandemic levels.

In figure 17, we plot the projected changes in interest liability on government debt (as a percentage of GDP) against the projected changes in the overall debt-to-GDP ratios over the next five years. The countries in the top-right quadrant – including the US, China, France, Italy, the UK, Brazil, Poland and South Africa – are those where a rise in both interest liability and debt burdens are projected. But the IMF projections also envisage declining debt burdens despite increases in interest liability. Yet again, large EMs, such as India, stand out where both the overall public-debt burden and the interest liability as a proportion of GDP are projected to decline. Other emerging markets with a relatively benign debt-to-interest liability profile are Indonesia and Mexico, where debt burdens are expected to stabilise along with modest shifts in interest liability (a decline, in the case of Mexico).

Demographics, productivity and trend growth

Demographics are a major structural category of public-debt drivers in an era of global population ageing. Rising old-age dependency would contribute to higher public debt through both higher government spending and lower trend growth rates.

According to the World Health Organization (WHO), by 2050, the world’s population of people aged 60 years and older will double, to 2.1 billion, from 1 billion in 2020. The chief reasons are rising life expectancy and lower fertility rates across much of the world. World Bank projections suggest that there is hardly any major economy where old-age dependency ratios will not rise by 2050, although several emerging markets are likely to have much lower old-age dependency ratios than most advanced economies, especially Japan and western Europe.

The implication of this global demographic deterioration is structurally higher public-debt-to-GDP ratios. Public expenditure will have to rise to equip social and healthcare systems to deal with the challenges of ageing populations. Looking at the relationship between a country’s old-age dependency and public debt, we find an interesting non-linear pattern. Population ageing typically tends to become a more serious issue for public debt only when the World Bank’s measure of dependency ratio exceeds the 30% mark. On this basis, there is scope for optimism that demographics-related headwinds to debt sustainability will still be manageable for several large EMs such as India, Indonesia and Turkey.

Moreover, unless offset by immigration and/or a rise in labour productivity, population ageing would mean significantly lower labour-force growth, which in turn would mean materially lower trend rates of growth. And lower trend rates of growth contribute to higher debt ratios through a variety of channels, including the need for governments to spend more to support growth, as we have seen in the case of Japan and are now seeing for China (see figure 20). Second, deteriorating demographics can also contribute to weaker productivity growth. As the workforce gets older, the economy’s capacity to innovate can decline, leading to a permanent loss in labour productivity. A European Stability Mechanism study reports a significant reduction in patent applications (a proxy for technological innovation) corresponding to rising old-age dependency ratios. In the wider cross section of countries, we see an inverse relationship between average rates of productivity growth/public-debt ratios (figure 20). The highest public-debt burdens globally tend to be found in economies such as Japan, Greece and Italy, with materially lower rates of average productivity growth.

Where have debt dynamics improved?

While public-debt dynamics have generally deteriorated since the global financial crisis, some countries have seen more benign debt dynamics or outright debt declines. We analyse a sample of 137 countries using the IMF’s WEO forecast comparing the latest public-debt-to-GDP ratio with the average public-debt ratio in the five-year period prior to the pandemic. On average, we find that public-debt-to-GDP ratio rose by 6 percentage points of GDP.

While most countries have seen public-debt ratios rise, we identify an investible group of 31 countries where public debt levels have either declined or risen below the global average. The group is selected to align with investment criteria for reserve managers. As a proxy for a sovereign’s institutional strength, we select countries with a minimum credit rating of BB-. Moreover, if a country in our group has a sovereign rating below investment grade (IG), then it is also required to have a positive outlook on its sovereign rating by at least one rating agency.⁷ A final criterion for inclusion in our benign debt dynamics group is that the country issue bonds included in the EMBI, WGBI, GBEU indexes to ensure we are excluding local currency denominated debt in emerging markets. The stock of investible debt in the subset of countries with favourable public-debt dynamics totals $11.7 trillion (see table).

There is significant overlap between the benign debt dynamics cohort of countries with countries that have performed strongly in our analysis of primary fiscal balance dynamics. Both hydrocarbon exporters and the eurozone sovereign-debt crisis countries featured prominently in our benign debt dynamics cohort of countries. Here again, it is important to consider initial conditions (while the 2.9% of GDP increase in the Italian public-debt ratio is well below the 6 percentage points of the GDP global average, Italy’s 136% debt-to-GDP ratio is quite high). Moreover, many of the emerging markets with benign debt/GDP dynamics have implemented favourable structural reform stories, and countries such as Turkey, Oman and Jamaica would fit into this category.

To assess whether there is a correlation between benign public-debt dynamics and outperformance, we measure monthly and annual returns of the benign debt dynamics cohort with the index performance of similarly rated peers. For developed-market countries, we look at total returns during the 2017–24 period and measure them against the total return of WGBI. For EM countries, we look at returns on a z-spread basis over the same period and compare them against EMBI of the similarly rated cohort (EMBI BB-rated returns or EMBI IG-rated returns depending on the sovereign’s rating).⁸ Our analysis does not show any correlation between benign debt dynamics and outperformance of sovereign bonds relative to the benchmark in the case of develop market bonds. For emerging markets, we did find a correlation with monthly returns of the benign debt cohort outperforming the index 56% of the time. The correlation between benign debt dynamics countries and annual returns was less robust (returns outperformed the index only 52% of the time).

Conclusion

A confluence of cyclical and structural factors signal that we are likely to see a structural increase in public debt for the foreseeable future. Whether it be less favourable demographic trends, increased demands for government spending, or a rising interest liability, the growth of aggregate debt stock is likely to mark the next chapter of financial history and present a growing challenge for both policy-makers and investors in sovereign debt. Understanding the drivers and the divergence among countries’ debt evolution will be key to staying ahead of market dynamics.

The policy implications of rising debt are numerous. In developed markets, where demographic trends are likely to be more adverse than in emerging markets, rising debt and fiscal pressures underscore the importance of adhering to fiscal frameworks that aim to bring down debt in the medium term. Credible medium-term fiscal frameworks have been important in improving debt dynamics in countries that have previously seen fiscal pressures affect the sustainability of fiscal financing. This is most recently evident in eurozone sovereign-debt crisis countries. These nations made politically difficult decisions in the wake of the crisis that are beginning to bear fruit in terms of sustainable public finances, declining debt/GDP ratios (in most cases) and sovereign credit rating upgrades. While a strong correlation was difficult to find between the performance of sovereign bonds from developed markets with robust fiscal frameworks, investors may still find an advantage in identifying these countries, as these bonds issued by these countries are likely to have fewer downside risks that could lead to credit rating downgrades and underperformance relative to benchmarks.

For policy-makers in emerging markets, where there is less of a demographic headwind and a broader converse trajectory in debt ratios, it will be increasingly important to implement productivity-enhancing structural reforms and to channel borrowed resources towards growth-enhancing investments, which will be able to mitigate the impact of demographic headwinds when they eventually arrive. Identifying those EMs whose trends can structurally improve will be particularly important for sovereign bond investors, given the evident correlation between sovereign credit rating upgrades, benign debt dynamics and bond returns in emerging markets.

If indeed divergence does mark the next sovereign-debt crisis, investors in sovereign bonds will do well to heed the incipient evidence supporting performance-related outcomes from debt management.

Notes

1. Financial Stability Oversight Council, Financial stability report, December 2024; US Federal Reserve Financial stability report, April 2024.

2. The mean primary balance improved, but this number is inflated by significant fiscal consolidations in a relatively small, unrepresentative group of countries.

3. Germany ran sizeable primary surpluses in the pre-pandemic period, so the nominal size of the 2023 primary deficit is relatively small.

4. Snudden, S, Cyclical Fiscal Rules for Oil-Exporting Countries, IMF, November 2013.

5. IMF WEO forecasts for primary fiscal deficit.

6. We took the average ex-post real rate by using the two-year nominal government bond yield and subtracting it from realised year-on-year inflation from the 2018–20 period and compared it with the current real rate using the same definition.

7. Historically, sovereign ratings with positive outlooks are between 62% and 69% likely to be upgraded in their next review, depending on the rating agency. Studies have found a positive correlation between ratings upgrades and outperformance of sovereign bonds relative to their indexes.

8. We measure EM on a z-spread basis because EMBI is in US dollars and we compare them with the ratings cohort because the variability of ratings in the EMBI is significantly wider than the WGBI.